DBRS Morningstar Downgrades Credit Ratings on 11 Classes of WFCM 2017-RB1, Changes Trends on Eight Classes to Negative from Stable

DBRS Limited (DBRS Morningstar) downgraded its credit ratings on 11 classes of the Commercial Mortgage Pass-Through Certificates, Series 2017-RB1 issued by Wells Fargo Commercial Mortgage Trust 2017-RB1 as follows:

-- Class E1 to B (high) (sf) from BB (sf)
-- Class E2 to B (sf) from BB (low) (sf)
-- Class E to B (sf) from BB (low) (sf)
-- Class F1 to CCC (sf) from B (high) (sf)
-- Class F2 to CCC (sf) from B (sf)
-- Class F to CCC (sf) from B (sf)
-- Class EF to CCC (sf) from B (sf)
-- Class G1 to C (sf) from B (low) (sf)
-- Class G2 to C (sf) from B (low) (sf)
-- Class G to C (sf) from B (low) (sf)
-- Class EFG to C (sf) from B (low) (sf)

In addition, DBRS Morningstar confirmed its credit ratings on the following classes:

-- Class A-4 at AAA (sf)
-- Class A-5 at AAA (sf)
-- Class A-S at AAA (sf)
-- Class A-SB at AAA (sf)
-- Class X-A at AAA (sf)
-- Class B at AA (low) (sf)
-- Class X-B at A (sf)
-- Class C at A (low) (sf)
-- Class X-D at BBB (sf)
-- Class D at BBB (low) (sf)

The trends on Class B, Class X-B, Class C, Class X-D, Class D, Class E1, Class E2, and Class E were changed to Negative from Stable. Class F1, Class F2, Class F, Class EF, Class G1, Class G2, Class G, and Class EFG have credit ratings that do not typically carry trends in commercial mortgage-backed securities (CMBS) ratings. All remaining classes have Stable trends.

The credit rating downgrades and Negative trends reflect the sizable loss projections associated with one of the specially serviced loans, 340 Bryant (Prospectus ID#17, 2.7% of the pool), paired with the high concentration of loans secured by office properties, representing 53.4% of the pool, several of which are exhibiting increased credit risk to the trust with exposure to more challenged markets in Connecticut and San Francisco. In addition, the capital structure of the transaction is noteworthy, as the junior tranches carry small balances, providing little cushion to mitigate against any additional loss and/or performance volatility for the remaining loans in the pool, supporting the credit rating actions.

The 340 Bryant loan is secured by a 62,270-square foot (sf), Class B office property in downtown San Francisco. In December 2021, the property’s largest former tenant, WeWork (77.0% of net rentable area (NRA)), terminated its leases ahead of their scheduled expirations in 2028 and 2029. While the tenant paid a termination fee of approximately $5.0 million, the borrower has been unable to backfill the space since the tenant’s departure, resulting in negative cash flow. The loan subsequently transferred to special servicing in September 2022 for imminent default as a result of the borrower’s inability to continue covering the debt payments, and as of the September 2023 reporting, foreclosure has been filed with the borrower’s cooperation. The remaining tenant, Logitech (23.0% of the NRA) has indicated that it will not renew upon the lease expiry in April 2024. Given the soft market conditions, low occupancy rate, and general challenges in backfilling the currently vacant space, the value of the property has likely declined significantly from the issuance figure of $52.0 million and has the potential to decline further. In its analysis for this review, DBRS Morningstar liquidated the loan from the trust based on a stressed value, resulting in an implied loss of nearly $12.5 million, or a loss severity in excess of 85%. Based on these results, the outstanding balance of Class H-1 would be written down by nearly 80.0%, significantly eroding the transaction’s credit support, particularly toward the bottom of the capital stack.

In general, the office sector has been facing challenging times, given the low investor appetite for the property type and high vacancy rates in many submarkets as a result of the shift in workplace dynamics. While select office loans in the transaction continue to perform as expected, DBRS Morningstar identified three loans backed by office properties, representing 16.4% of the pool, showing performance declines from issuance or otherwise exhibiting increased risks from issuance. These loans were analyzed with stressed scenarios, including increased probability of default (POD) penalties and/or increased loan-to-value (LTV) ratios, as applicable, to increase the expected losses. The resulting weighted-average (WA) expected loss for the these loans that were adjusted was approximately 1.75 times (x) the pool WA figure.

One of these loans is Center West (Prospectus ID#3, 7.4% of the pool), which is secured by the leasehold interest in a 349,298-sf, Class A office property in the CBD of Los Angeles. The loan has been on the servicer’s watchlist since December 2021 as a result of increased vacancy and a low debt service coverage ratio (DSCR). At issuance, the property was only 57.1% occupied, as a result of the borrower’s selective leasing strategy to only high-quality and established tenants; however, occupancy has since fallen to 34.8% as of February 2023, likely because of both the borrower’s preference and the current market conditions. Per the YE2022 financial reporting, the loan reported a net cash flow (NCF) of $2.3 million (a DSCR of 0.64x), well below the DBRS Morningstar figure derived at issuance of $6.3 million (a DSCR of 1.76x), reflecting a 35% NCF decline. While the sponsor has maintained the loan as current despite the operational shortfalls with a large equity contribution to the relatively low-leverage financing at issuance, reflecting a going-in LTV of 38.3% (based on the whole-loan balance of $80.0 million and the issuance appraised stabilized value of $256.0 million, value has likely declined significantly since issuance, elevating the loan’s refinance risk approaching 2026. As a result, DBRS Morningstar applied a POD penalty and assumed a stressed LTV for this loan, resulting in an expected loss (EL) that was more than 2.0x the pool WA figure.

Another office loan of concern is 1166 Avenue of the Americas (Prospectus ID#8, 5.3% of the pool), which is secured by the first five floors of a Class A office property in Midtown Manhattan. The loan was added to the servicer’s watchlist in July 2023 because the largest tenant, The D.E. Shaw Group (D.E. Shaw; 43.6% of NRA) confirmed that it will be vacating its space upon lease expiration in June 2024 (although it may extend the lease by an additional three to six months beyond the scheduled lease expiration date). The second largest tenant, Arcesium (20.0% of NRA), has a lease guaranteed by D.E. Shaw and also has a lease expiration in June 2024. Arcesium is reportedly looking for space elsewhere; although, a final decision has not been communicated. While the servicer has reported that a 10-year lease is currently being negotiated with a prospective tenant that could occupy most of the third floor (between 15.0% and 20.0% of NRA), occupancy will likely experience volatility over the near to medium term.

The property generated NCF of $9.8 million in 2022, resulting in a DSCR of 2.20x, which compares favourably with the issuance figures of $8.2 million and 1.80x, respectively. The loan is also structured with a cash sweep that was triggered when D.E. Shaw and Arcesium failed to provide notice of renewal 18 months prior to their June 2024 lease expirations. The cash sweep, which will aid the borrower in its releasing efforts, is structured to trap all excess cash until an amount equal to $75.0 psf is collected. According to the September 2023 reporting, the tenant reserve balance is approximately $2.1 million.

While the upcoming lease rollover is noteworthy, the loan benefits from structural mitigants, namely, the low going-in LTV ratio of 48.9% (based on the whole-loan balance of $110.0 million and the issuance appraised value of $225.0 million) and the cash sweep provisions, which are designed to help mitigate rollover risk by offsetting leasing costs. Moreover, the loan’s maturity date in 2027 will provide the sponsor time to backfill vacant space and work toward stabilization once tenants begin rolling in 2024. Furthermore, the property benefits from its excellent location in Manhattan and a strong loan sponsor, Edward J. Minskoff Equities, Inc. (EJME), a privately held real estate investment and development firm based out of Manhattan. EJME has ownership interests, leases, and/or manages more than 4.0 million sf of commercial real estate space, which includes other prominent New York properties such as 51 Astor Place and 590 Madison Avenue. In its analysis, DBRS Morningstar increased the POD penalty and LTV ratio for this loan, resulting in an EL that was approximately 1.4x the pool WA average.

As of the September 2023 remittance, 33 of the original 37 loans remain in the pool with an aggregate principal amount of $543.2 million, representing a collateral reduction of 14.8% since issuance as a result of scheduled amortization, loan repayment and liquidation of one loan. Three loans representing 3.5% of the pool balance have been fully defeased. The pool is concentrated by loan size, with the top five and ten loans comprising 40.7% and 64.7% of the pool balance, respectively. There are only six loans on the servicer’s watchlist, representing 25.2% of the pool, and two loans, representing 7.0% of the current pool balance, in special servicing.

The second specially serviced loan, Anaheim Marriott Suites (Prospectus ID#10, 3.9% of the pool), is secured by a 371-room, full-service hotel located in Disneyland, California. In its previous review, DBRS Morningstar had liquidated this loan from the trust in its analysis with a minor implied loss in excess of $2.0 million; however, the borrower recently signed a reinstatement agreement in July 2023 and the loan was brought current. The loan is expected to remain with the special servicer for a period of monitoring before being transferred back to the master servicer; however, performance has shown significant improvement, reporting a DSCR of 1.21 times (x) as of YE2022. While performance is trending in the right direction, a recent appraisal dated June 2023 valued the property at $64.5 million, reflecting a 22.3% decline in value when compared with the issuance value of $83.0 million. As a result, DBRS Morningstar applied a stressed LTV assumption based on the updated value, resulting in an EL more than twice the pool average.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (July 4, 2023), https://www.dbrsmorningstar.com/research/416784.

Class X-A, Class X-B, and Class X-D are interest-only (IO) certificates that reference a single rated tranche or multiple rated tranches. The IO rating mirrors the lowest-rated applicable reference obligation tranche adjusted upward by one notch if senior in the waterfall.

All credit ratings are subject to surveillance, which could result in credit ratings being upgraded, downgraded, placed under review, confirmed, or discontinued by DBRS Morningstar.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is North American CMBS Surveillance Methodology (March 16, 2023) https://www.dbrsmorningstar.com/research/410912.

Other methodologies referenced in this transaction are listed at the end of this press release.

The credit ratings assigned to the Class B and Class D materially deviate from the credit ratings implied by the predictive model. DBRS Morningstar typically expects there to be a substantial likelihood that a reasonable investor or other user of the credit ratings would consider a three-notch or more deviation from the credit rating stresses implied by the predictive model to be a significant factor in evaluating the credit rating. The rationale for the material deviation is uncertain loan-level event risk. The analysis for this review included stressed scenarios for several office loans given the general challenges facing the sector. The results of the analysis suggested downward pressure through the middle of the bond stack following the credit rating downgrades, which are most pronounced for Class B and Class D; however, given the most challenged loans would likely be transferred to special servicing and possibly liquidated, DBRS Morningstar believes that the increased risks are mostly concentrated in the lowest-rated classes, supporting the Negative trends assigned with this review continuing to display downward pressure.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

Please see the related appendix for additional information regarding the sensitivity of assumptions used in the credit rating process. Please note a sensitivity analysis is not performed for CMBS bonds rated CCC or lower. The DBRS Morningstar Long-Term Obligation Rating Scale definition indicates that credit ratings of CCC or lower are assigned when the bond is highly likely to default or default is imminent, thereby prevailing over a sensitivity analysis.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and credit ratings are monitored.

DBRS Limited
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Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

North American CMBS Multi-Borrower Rating Methodology (March 16, 2023)/North American CMBS Insight Model v 1.1.0.0 (https://www.dbrsmorningstar.com/research/410913)

Rating North American CMBS Interest-Only Certificates (December 19, 2022; https://www.dbrsmorningstar.com/research/407577)

DBRS Morningstar North American Commercial Real Estate Property Analysis Criteria (September 22, 2023; https://www.dbrsmorningstar.com/research/420982/)

North American Commercial Mortgage Servicer Rankings (August 23, 2023; https://www.dbrsmorningstar.com/research/419592)

Interest Rate Stresses for U.S. Structured Finance Transactions (June 9, 2023; https://www.dbrsmorningstar.com/research/415687)

Legal Criteria for U.S. Structured Finance (December 7, 2022;
https://www.dbrsmorningstar.com/research/407008)

A description of how DBRS Morningstar analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/417279.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].